Market Overview | Second Quarter 2021
This summer’s heat has broken temperature records here in Minnesota and in other parts of the country. Meanwhile, both the economy and the overall market have also been posting some record-breaking temperatures as vaccination rates rise and the pandemic lifts.
As we look back on the market’s performance in the first half of 2021, what’s particularly striking is that, in general, stocks that were hot performers in 2020 have cooled off this year, and vice versa. In some cases, that’s true of entire sectors. Energy, a laggard last year, has been one of the top-performing sectors this year. Small caps, which underperformed the S&P 500 in 2020, are outpacing the index in the first two quarters of 2021. Conversely, Technology has underperformed the S&P 500 year to date after posting huge gains in 2020, though some tech stocks are still outperforming.
The S&P 500 Total Return (TR) Index rose 8.55% in the second quarter of 2021, while the Dow Jones Industrial Average TR Index (DJIA) climbed 5.08%. Year to date, the S&P 500 TR Index is up 15.25% and the DJIA TR Index has gained 13.79%. In the fixed-income market, the Bloomberg Barclays U.S. Government/Credit Bond Index rose 2.42% in the second quarter, though it is down 1.96% year to date.
Future Outlook
Along with the hot market and hot economy, the hot topic this year has been inflation. The May CPI (consumer price index) was up at an annualized rate of 5%, the highest rate of inflation since 1993. It follows annualized CPI inflation numbers of 3.8% in April and 3.0% in March. The ongoing semiconductor shortage has driven up the price of cars, computers, even window air-conditioning units. Prices have also moved up sharply for travel-related services such as airfare, hotel rooms, and rental cars. That noted, the Federal Reserve believes that inflation is “transitory” and should abate later this year. And in the past month, the market also seems to have become less worried.
The broad economic indicators have been sizzling during the first half of 2021. In June, the Institute of Supply Management (ISM) manufacturing index hit 61.2, up from 60.7 in May. The June ISM services index was 64.0, compared to 62.7 the month before. Any number over 50 signifies growth — over 60 means business is barbecue-hot. A federal infrastructure plan would add even more fiscal fuel to the fire.
But other indicators show signs of cooling off. Each of the 12 Federal Reserve districts has its own regional economic index. The Philadelphia, Dallas, and New York Feds all posted strong numbers in June, but all were down from May. (Chicago’s index was up slightly.) This suggests that the economy isn’t quite as torrid as it was earlier this year.
Another sign of a cooling trend — consumer confidence decreased slightly in May, the first monthly decline this year. While May retail sales were up 28% compared to May 2020, that was down from year-over-year growth of 51% in April.
Despite the hot economy, job growth has been much slower than expected. And that’s despite higher wages and a record number of job openings — 9.3 million as of June 8. Experts cite several reasons for people staying out of the labor force, including ongoing pandemic worries, difficulty in finding childcare, and people earning enough on unemployment to stay financially afloat. As these barriers recede, job growth should improve later this year.
Last year, when Covid-19 first hit, we expected (along with many others) that the pandemic would cost companies two years of earnings growth. In other words, earnings wouldn’t regain 2019 levels until 2022 at the earliest. But the current consensus is that S&P 500 corporate earnings are currently within a percent of where they were before the pandemic, an astounding comeback. In the first quarter, earnings for the S&P 500 were 50% above the first quarter of 2020. As of mid-June, the consensus was that S&P 500 earnings would post growth of 61% in the second quarter compared to last year. Earnings growth also is expected to cool a bit this fall, with consensus predictions of 24% growth in the third quarter and 16% in the fourth quarter. For the full year 2021, we estimate that earnings will be 13% above the number reported for 2019.
Performance Review
The Mairs & Power Growth Fund gained 8.84% in the second quarter. During the same period, the S&P 500 Total Return (TR) benchmark rose 8.55%, and the Lipper Multi-Cap Core Funds Index of peers posted a gain of 5.00%. Year to date, the Fund was up 16.73% while its benchmark has gained 15.25% and the peer index was up 14.23%.
The primary driver of the Fund’s relative performance both quarterly and year to date was stock selection. The only meaningful sector weight that impacted relative performance was our lack of exposure to the Energy sector. As the global economy has snapped back, so has oil demand. We believe this is a short-term phenomenon, and we expect energy prices and sector performance to weaken over the long term.
The top contributors to Fund performance in the quarter and year to date have been Google parent Alphabet (GOOG, Financial), Bio-Techne (TECH, Financial), and Nvidia (NVDA, Financial).
Alphabet has performed strongly after somewhat lagging its big-tech brethren last year. It is now the Fund’s second largest position, so its outperformance has had a significant impact on the portfolio. The company is monetizing its YouTube business with increased video advertisements, and it should benefit further as travel and leisure advertising spend rebound.
Bio-Techne continues to deliver accelerating organic revenue growth from the acquisitions and investments it has made over the last several years. The company is particularly enthusiastic about the potential for its exosome diagnostics business and its first commercial product, a urine test for prostate cancer. It is also seeking FDA approval for a transplant rejection test. In addition, Bio-Techne has invested internally in larger-scale bio-manufacturing, and it will likely see a significant revenue ramp up in that business over the next several years.
And Nvidia is booming as demand for its graphics cards accelerates, particularly from data centers and in artificial intelligence (AI) and machine learning (ML) applications. Some of the company’s cards are also used in mining cryptocurrencies, a situation we’re monitoring closely, since declines in crypto prices can cause the market to be flooded with used cards. Longer term, we continue to be excited by the growth potential in Nvidia’s core gaming market, as well as the AI and ML opportunities.
The Fund’s most significant performance laggards year to date are Qualcomm (QCOM, Financial), Fiserv (FISV, Financial), and Ecolab (ECL, Financial).
Qualcomm has been hurt by the semiconductor shortage, since it makes the bulk of its revenue from chips used in consumer electronics and cell phones. We believe that supply problems will improve. Until then, the stock will probably struggle to outperform the broader market.
Fiserv’s payment processing revenue should snap back as the country and the world reopen from the pandemic. We are seeing significant investment flowing into potential competitors in the so-called fintech space. This is why we like Fiserv’s acquisition of fintech firm Clover, which should help it fend off new competition. The company should also benefit as its traditional banking customers continue to invest in additional digital capabilities.
As for Ecolab, it had always garnered a significant premium relative to the market due to its consistent organic growth. However, with a new CEO and an uncharacteristic misstep in entering and then exiting the energy space, Ecolab now is something of a show-me stock. Increased raw material costs could hurt margins despite a recovery in volumes, putting further pressure on the stock. We remain long-term believers in the company, and we expect that it will emerge in a stronger competitive position when its end markets rebound.
The rejuvenated performance of small and mid-caps this year has presented the Fund with some intriguing opportunities. In the second quarter, we added two such stocks, both Minnesota companies.
Inspire Medical Systems (INSP, Financial) is a med-tech company, founded by former Medtronic executives, that uses technology similar to that found in defibrillators and pacemakers to treat obstructive sleep apnea. Inspire’s implantable device gives the muscles in the back of the tongue a small “shock” to keep it from blocking air flow. Inspire anticipates a $10 billion market for its device, which can replace bulky CPAP machines. What’s more, it has obtained reimbursement from major insurers, including Medicare. Though a high-valuation company, Inspire has a potentially large market opportunity.
We also added recreational vehicle manufacturer Polaris (PII, Financial), whose current valuation looks very attractive. While its revenue and earnings have been constrained by supply chain difficulties, demand is strong and is likely to remain so. Longer-term, we see opportunities for the new management team to streamline the portfolio and to make use of new technologies that further differentiate its products.
Andrew R. Adams, CFA, CIC
Lead Manager
Pete J. Johnson, CFA
Co-Manager
Performance data quoted represents past performance and does not guarantee future results. The investment return and principal value of an investment will fluctuate so that an investor’s shares, when redeemed, may be worth more or less than their original cost. Current performance of the Fund may be lower or higher than the performance quoted. For most recent month-end performance figures call Shareholder Services at (800) 304-7404.
This commentary includes forward-looking statements such as economic predictions and portfolio manager opinions. The statements are subject to change at any time based on market and other conditions. No predictions, forecasts, outlooks, expectations or beliefs are guaranteed.
